September 2018 Investor Report

Published: September 25, 2018Updated: April 25, 2019

As the United States’ economy
approaches its tenth consecutive year of growth and the burgeoning “trade war” with
China enters its seventh month, we are indeed in very rare times.
Unfortunately, when economic growth enters a period as long as this, historically
the closer an economic pullback comes (not necessarily a recession).

The US applied a ten percent
tariff on about $200 billion worth of Chinese imports on September 24.
Additionally, the US will raise the tax to 25 percent in the first quarter of
2019. Predictably, the Chinese government will levy retaliatory tariffs in
response. Damage to China’s growth and Asia’s supply chains is being noted by
many economists. The effects on the United States has been relatively muted
compared to China, however, American business owners have issued warnings in
their quarterly reports that they will need to raise prices on American
customers sooner than expected. The timing could not be worse; the American
economy is entering its peak retail season. With the holidays around the corner
and household debt levels at highs for recent history (2007-2008 levels), the
outlook is not good. Up to now, business owners have been able to cut costs
without increasing prices on consumers. This appears to be coming to an end and
prices will head higher for the holidays. It is our hope that some agreement
will be in place by that time.

Separately, last month, Jamie Dimon, Chairman and CEO of J.P.
Morgan Chase, said people should prepare for U.S. yields of five percent and
warned investors that borrowing costs throughout the economy are likely to
rise. Speaking at the Aspen Institute he said, “I think rates should be four
percent today,” Dimon said. “You better be prepared to deal with
rates five percent or higher—it’s a higher probability than most people think.”
Given Mr. Dimon’s prominent position in the banking industry, his expectation
that interest rates and borrowing rates are going to increase can have a
material impact on businesses and households that have a lot of debt. As with
every economic downturn in the modern history of the United States, debt and
the prospects of paying more for debt (interest expense) will systemically slow
growth rates as money cannot be spent on growth related projects like research
and development.

Please review the following updates from some of the existing
positions that we manage:

Diana Shipping (DSXN)
– On September 18, the company announced it will be raising a new $100
million debt offering via a private placement. Unfortunately for us, Diana will
use those proceeds with other cash to retire our bonds early. We will continue
to look for new opportunities to replace the yield lost from this bond. We are
projecting the bonds to be redeemed in the last week of October.

Aspen Insurance
Trust Preferred Stock (AHL-C) – This QDI (Qualified Dividend Income) paying
preferred stock was recently upgraded by Moody’s. The more important news is
that the Aspen Insurance Trust is being taken private by Apollo Global
Management, one of largest private equity firms in the world. Our preferred
stock will remain publicly traded. Recently, we started to add the positions to
new accounts as the value of the stock came back to a range at which we deem
the stock to have good value. As a reminder, the preferred stock will become a
floating rate investment in the summer of 2023 (this helps offset interest rate
risk). The ability to generate over 5.5 percent yield from a company with an
investment grade balance sheet and lower duration risk is attractive. This does
not include the QDI benefit where investors in the higher tax brackets benefit
for paying a lower flat tax. For estates in the 38 percent income tax bracket,
the taxable equivalent yield is closer to 6.8 percent.

PHI Bonds maturing
March 2019– We tendered our bonds
back to the PHI for $1010.00 plus accrued interest. The bonds are still
tendered as the company determines how it will refinance their bonds. This
event, once again, is a reminder of the advantages of being a bond holder over
an equity shareholder as we have priority, in this situation, over everyone
(including the controlling shareholder). The sale of one of PHI’s divisions is
expected to finance the buyback. We continue to collect accrued interest at a
5.5 to six percent rate while we wait for the sale process to conclude.